Simplex Infrastructure

Simplex Infrastructure is well-diversified across the construction space and it is reasonably valued too. However, there are some caveats which need to be looked at

OVER THE past one year, construction companies, especially in the midcap space, have been hammered on the bourses. The stocks have lost between 65-75% in value triggered by fears of slowing down of orders and also high interest costs affecting the profitability of the companies.

However, in the last one month, most stocks in the segment have gained 30-50%. The two stimulus packages announced by the government are likely to have a positive rub off on the sector. Mid-cap companies are also likely to gain, especially those with a diversified portfolio. Simplex Infrastructure fits the bill perfectly. The company looks undervalued compared to its peers and is a good buy for long-term investors.

BUSINESS

Simplex Infrastructure is an eighty-four-year-old company which started off with piling (ground engineering) operations in 1924. It has added various businesses and successfully diversified into industrial construction, building and housing, urban infrastructure, power, marine and transport (roads, railways and bridges).

The company was also planning to venture into oil rigs and real estate business in a big way. It entered into a two-year contract in mid 2007 with Oil India for leasing a 1,500 HP rig at $16,000 per day for on-shore exploration. However, with the fall in crude oil prices and consequent decline in the day rates and also the downturn in the real estate market, the company has held back the plans.

STRONG ORDER BASE

The company provides strong revenue visibility with an order backlog of Rs 10,600 crore; nearly three times its trailing four quarter revenues. Going forward, the company plans to focus on highgrowth segments like power, marine, railways, bridges and urban infrastructure. According to the company, it is pre-qualified for projects worth Rs 28,000 crore while Rs 7,000 worth of orders are in the L1 stage (short-listing pending after bidding). The company's strike rate is around 20%.

FINANCIALS

In the trailing four quarters, net sales leaped by 70%, while growth in operating profit and net profit trailed at 61% and 65%, respectively. In the December '08 quarter, we expect the company to report 45% growth in revenues to Rs 1019.2 crore. Operating profit margins are expected to decline marginally by about 40 basis points to 9.6%. About 92% of its contracts are on a variable basis and any savings in costs are likely to be passed on to customers. Net profit is expected to grow at a slower 30% to Rs 28.5 crore due to higher fixed costs (read interest and depreciation) and taxes.

KEY CONCERNS

Investors need to keep a watch on future order inflows, which could get affected due to the economic slowdown and credit crunch. Also, the buildings and housing segment that constitute 28% of the total order book, could witness some pressure.

Another concern is the relatively high debt to equity ratio of over 1 in FY '08, which is expected to rise further to 1.5 by the end of FY '09. The company has raised Rs 220 crore through issue of 5.5 million warrants in FY ‘08, which are convertible into equity at Rs 401 per share by end of FY '09. With the stock currently trading at Rs 172, cancellation of conversion cannot be ruled out, in which case debt and interest costs could rise further.

The company also has a poor interest coverage ratio of around two in FY '08 as compared to over 3-3.5 times for IVRCL and Nagarjuna Construction. The company's operating cash flow has been negative for three financial years prior to FY '08. Cash flow may come under pressure due to the economic slowdown, delays in the projects/payments and higher interest costs.

VALUATION

At its current price, the stock is trading at around 6.4 times its earning for trailing four quarters ending September ‘08. This is much lower than the valuations of its nearest peers namely Nagarjuna Construction (7.9 times). It trades at 5.6 times and 3.8 times its estimated earnings for FY '09 and FY '10 (diluted) respectively. This provides an attractive opportunity for investors to accumulate stocks at dips.